Directors’ and officers’ liability in bankruptcy due to breach of accounting obligation

When a private company goes bankrupt, the directors and officers can be held liable for all debts of the bankruptcy. This applies in cases of improper management. The trustee shall always investigate this and if necessary shall institute proceedings against the director or officer involved. Based on a recent ruling of the Court of Appeal, insolvency lawyer Sander Schouten explains how such proceedings work.

Directors and officers in breach of legal accounting obligation

In this case the managing directors of a bankrupt company had failed to comply with their accounting obligation. The law states that a breach of the accounting obligation is considered improper management. If a company goes bankrupt, this manifestly improper management is considered to be an important cause of the bankruptcy, based on directors’ and officers’ liability. This is a broad general term for the liability of the directors and officers of a legal entity towards either that legal entity or towards one or more creditors or other interested parties in that legal entity. The law has some specific stipulations about directors’ and officers’ liability. Based on these stipulations, the trustee can attempt to recover the debts from the directors and officers.

Presumption of improper management: counterproof

In the proceedings that the trustee had instituted against the directors and officers, the directors and officers were allowed to prove that there were other causes of the bankruptcy than improper management. The directors and officers therefore had the opportunity to disprove the legal evidentiary presumption. The directors and officers stated that the bankruptcy was caused by a number of factors. Among others the increasing competition by Eastern European companies and a loss on a major project caused the bankruptcy. However, the Court of Appeal did not find that the directors and officers argued convincingly that these factors were a major cause. In other words, the directors and officers did not succeed in offering counterproof.

Mitigation for minor severity of improper management

The directors and officers then invoked mitigation. They stated that the breach of a “light standard” such as the accounting obligation, is not proportional to the far-reaching consequences, i.e. complete liability for the debts of the bankruptcy. The Court of Appeal finds that the directors and officers fail to recognize that a breach of the accounting obligation means that the directors and officers improperly managed the legal entity across the board, not just concerning their administrative duties. This improper management of the company across the board is presumed to be the cause of the bankruptcy. Lacking proper counterproof, the Court of Appeal does not agree with the directors and officers that the severity of the improper management “isn’t that bad”. There is therefore no room for mitigation.

Lawyer for directors’ and officers’ liability

The court can mitigate the amount for which the directors and officers are liable if the court considers this amount to be excessive. The nature and severity of the improper conduct of their duties by the management, the other causes of the bankruptcy and the manner in which the bankruptcy was settled, are all taken into account. The court can also rule that mitigation is reasonable for an individual director or officer, due to his (limited) part in the improper management. If you have any more questions about directors’ and officers’ liability in bankruptcy, please contact one of our insolvency specialists.